Question 1:

Following the end of the World War II, western countries adopted the principle of “embedded liberalism” as a guiding principle in the world’s economic relations. This principle was consistent with the ideas espoused by John Maynard Keynes. By late 1970s due to the series of economic recessions, the world economy was turning away from the Keynesian model towards the vision advocated by Fredrich von Hayek. However, despite the arguable triumph of Hayek’s ideas at the end of XX century, the new millennium started in the shadow of the 1990s Asian financial crisis, 9/11, a series of corporate scandals (Enron), stalemate at the WTO, uncertainty over the world’s stock markets, and a growing credit crunch in the United States.

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

 

1)      Examine and discuss the conflicting ideas of John Maynard Keynes and Fredrich von Hayek in the context of the post war (1945-2005) economic policy making and international trade.

2)      Which of the two sets of ideas, if any, can better address the current situation in the world economy?

3)      If you were to meet them next month, what would be your economic policy recommendation for the world’s most influential leaders? Explain

 

 

 

 

The economic models that have shaped the post World War II domestic economic policies in western countries and international trade have been influenced notably, by two great economists of the 20th century – John Maynard Keynes and Fredrich von Hayek. (PBS, 2002)

Keynesian economic theory posited that there was a fundamental error in classical economics’ concept that the forces of demand and supply (or competition) would make full employment possible. To Keynes, the fluctuations and uncertainties in the national economy could not stabilize at an equilibrium just based on the outplay of the forces of demand and supply in the market. (Yergin and Stanislaw 1998) In an environment of uncertainty and instability when the economy is in a down turn, people refuse to spend and investments are not forth coming from the private sector. To rectify the apparent inability of the private sector to deal with the lack of investment and spending, Keynes proposed the need for the government to intervene to manage the economy and rectify the instability. (PBS, 2002)

To Keynes, government needed to spend to make up for the inability of the private sector to invest. Public investment funded by government thus filled the missing link of private investment. Government would thus run deliberate deficits through public expenditure. (Yergin and Stanislaw 1998) Increased government expenditure would generate jobs which would in turn increase the purchasing power of people. The concepts of gross national product (GNP), aggregate demand, and the multiplier, postulated by Keynes became the foundational basis of macroeconomics i.e. the employment of fiscal policy by government through spending, deficits, and taxation.

 

GNP estimates in monetary terms, the total value of all the products and services produced within a country during a specified period in the year by the factors of production, while aggregate demand can be used at the macroeconomic level to analyze the grand total of produced and purchased goods and services. (Johnson n.d.) The multiplier concept held that government spending would create jobs for people who would in turn spend money gained from employment in the economy. The spending of employed people in the economy would also result in a positive ripple effect of creating more jobs and thus solving the problem of unemployment.

Conversely, Keynes was of the opinion that when the economy was experiencing growth and stability, government must cut back spending. This would reduce the money in circulation within the economy and prevent inflation. (PBS, 2002)

It is important to note that Keynes’ economic philosophy was greatly shaped by the economic uncertainties and fluctuations of his time, especially during the Great Depression of the1930s. The economies of Europe and America experienced catastrophic slumps after World War I. It thus appeared then that the classical liberal economic theory of self regulation in the market through the forces of demand and supply had failed to stabilize the market. (PBS, 2002) The so called ‘invisible hand’ of market self regulation appeared very invisible in the face of market failure. Economic instability was thus giving room for the advancement and appeal of socialism and fascism in a lot of European countries. By 1922, Russia had adopted a totalitarian form of socialism. Eventually, Italy also became fascist under Mussolini and so did Germany under Hitler’s Nazi government. (PBS, 2002)

All these drives toward totalitarianism were greatly generated and spurred on by the economic catastrophes of the era. The need to take collective action to deal with colossal economic problems appeared more appealing than the conventional individualistic propositions of liberalism under capitalist conceptions. Thus the Keynesian concept of government intervention in the economy through macro-economic planning and management was seen as a solution to not only the precarious economic boom-bust, but also, a way of preventing the total annihilation of capitalism by socialism and totalitarianism. (PBS, 2002) In effect, though Keynes was not pro socialist, he favored planning of the national economy by government which meant more government intervention or regulation of the market.

Fredrich von Hayek’s philosophy of economics was at variance with the Keynesian model and all other forms centralized planning of the economy like socialism. To Hayek (1944) “Economic liberalism is opposed, however, to competition’s being supplanted by inferior methods of coordinating individual efforts. And it regards competition as superior not only because it is in most circumstances the most efficient method known but even more because it is the only method by which our activities can be adjusted to each other without coercive or arbitrary intervention of authority.” (p.36) Hayek favored a free market economy where competition was allowed to regulate the market with very minimal government intervention. Cosequently, any form of central planning that controlled price and set production quotas negated the power of competition to effectively coordinate efforts of the individual in the market, as centralized planning fails to take cognizance of the peculiarities of individual situations that inform the individual’s action in the market. (Hayek 1944, p.27)

Hayek’s view of a liberalized market economy where the market regulated itself through competition, was founded on his passion for individualism or the liberty of the individual to choose how he/she engaged in the market, as against collectivism and totalitarianism that sort to present a form of generalized blue print for collective conduct in political and economic affairs.

It is important to note however, that Hayek’s view of economic liberalism was not an endorsement of unbridled capitalism or laissez-faire principles. To him “nothing has done so much harm to the liberal cause as the wooden insistence of some liberals on certain rough rules of thumb, above all the principle of laissez-faire”. (Hayek, 1944, p.13) Regulation of the market was thus necessary but only the extent of creating a viable environment for competition to thrive. In Hayek’s words:

“The functioning of competition not only requires adequate organization of certain institutions like money, markets, and channels of information – some of which can never be adequately provided by private enterprise – but it depends above all on the existence of an appropriate legal system, a legal system designed both to preserve competition and to make it operate as beneficially as possible.” (Hayek 1944, p.28)

From the above, it can be realized that the main point of conflict between Keynes’ economic philosophy and that of Hayek had to do with the level of planning or government intervention in the market. Whereas Keynes favored a more active role by government in planning the economy, Hayek favored a limitation of government’s role to the bare necessities of regulation and organization that ensured the working of competition.

At the end of the end of World War II, the Keynesian view held sway in the economic policies of western states. In 1945, Britain under the Labor government of Tony Benn nationalized the coal, railway and steel industries with the view to making these industries work for the common good and not for the personal enrichment of private owners and shareholders. The welfare state implemented by the western economies during the post World War II era thus typified the ethos of active government planning of the economy that Keynes espoused. (PBS, 2002)

Also, the need for good economic relations among states after World War II became very important as the ‘Smoot-Hawley’ type of tariff hikes in trade policies was perceived to have contributed to the degeneration of international relations among states during the inter-war war period and partly accounted for the outbreak of World War II. (Sutherland et al, 2008) The challenge to economic planning in the post World War II era was thus, how to strike a balance between active government planning in the domestic economy as proposed by Keynes and liberalisation of trade at the international level so as to prevent a reocurrence of the tariff hike competition among states that prevailed in the inter-war period.

The principle of embedded liberalism was thus adopted as a form of equilibrium between active government planning in the welfare state (the Keynesian model) and liberalised international trade at the international level. (Wolfe and Mendelsohn, 2004) Embedded liberalism also made room for multilateralism in international economic affairs while allowing individual states the choice or preference of implementing the economic philosophy of their choice. The formation of the Bretton Woods institutions – the World Bank, the International Monetary Fund (IMF), and the General Agreement on Tariff and Trade (GATT) – thus reflected both the triumph of Keynesian economic philosophy and its compromise with a regulated multilateral set up that had oversight of international monetary policy and international trade policy.

This compromise was further discernible in the GATT which made room for Contracting Parties to pick and choose the specific areas that they wanted to commit to in the GATT. (Van den Bosch, 2005)

The continued persistence of Keynesian economics in western states from 1945 however meant that governments still had a strong hold on key trade policy decisions like tariffs and quotas on imports and exports. Liberalised international trade under the GATT went as far as concessions on tariffs and quotas made by states during multilateral trade negotiations held under the auspices of the GATT. Significant tariff and non-tariff bariers to trade and active government participation in markets thus epitomised the period from 1945 to the late 1970s.

By the late 1970s, increased economic recession had precipitated a rethink of the Keynesian economic propositions and the ideals espoused by Hayek started gaining acceptance as the most appropriate model for domestic and international economic policy. (PBS, 2002) Privatisation of state owned enterprises in Britain under Margaret Tatcher and deregulation of the American economy under Ronald Reagan, for instance, captured the shift from Keynesian economics to Hayek’s model of economic liberalism. (Yergin and Stanislaw 1998) At the international level, reductions of tariffs and quotas on imports and exports signified the change in economic policy. Most developed countries systematicaly reduced tariffs to zero per cent and lifted quotas on imports. Some developing countries of that era, like Korea, Singapore, Taiwan, Chille, Malaysia and Indonesia, who went along with the tide of free market reforms recorded high growths in their economies and moved from developing, to newly developed countries by the 1990s. Regional free trade groupings also sprang up of which the European Union (EU) and the North American Free Trade Agreement (NAFTA) are most notable. Probably, the most notable of the free trade groupings would be the EU which starting as an organisation of European coal and steel producing coutries after World War II, – i.e. European Coal and Steel Community (ECSC) – metamorphosed through systematic stages of integration and deregulation of trade, into the present EU which currently boasts of a customs union, a single internal market and a monetary union of 26 European states.

At the international level, the exigencies of the free market economy necessitated a reorganisation of the GATT to reflect the needs of the time. During the Uruguay Round of  trade negotiations, more disciplines like the regulation of subsides and intellectual property rights were brought under the multilateral trade regime. (Van den Bossche, 2005) The new broadened mandate of the multilateral trade system culminated in the World Trade Organisation (WTO). The signing of a single undertaking under the Agreement Establishing the WTO meant that WTO Member States and accedding states are bound by all the multilateral rules administered under the WTO. The practice of selective commitment under the GATT (i.e. GATT a la carte) ended with the advent of the WTO. Thus the market liberalizing effects of the principles of non-discrimination (most favored nation and national treatment) under the WTO further extended free market principles to an international level. The regulation of subsidies under the WTO for example implied that governments could not use import subsidization to protect domestic industries from competition from imported goods, whereas the prihibition of export subsidies prevented a distortion of prices of goods on the international market and thus fostered market competition at a global scale.

All these collosal economic changes that perhaps reached its peak in the 1990s typified the trend towards market economy that even former communist economies like China, Russia and the Eastern European countries had sarted adopting. By the start of the new mellinium, the general consensus was in favour of market liberalism as opposed to a centralized planned economy. Demsetz (2002) captures the economic liberalism consensus thus:

“Economic systems organized to rely on sympathetic feelings cannot succeed in coping with day-to-day resource allocation tasks. This is not to say that these types of economic systems cannot exist, that they cannot persist, or that they cannot alter the distribution of wealth. It is to say that they cannot resolve resource usage problems as efficiently as can systems that rely to a greater extent on prices that reflect facts known to and actions taken by dispersed private owners. It is delusion to think that a socialist organization dealing with modern economies will make allocation decisions on the basis of kinship emotions, although in times of national emergency, such emotions do exhibit strength for relatively short periods.” (p.662)

It is worthy of note that in spite of the supposed triumph of economic liberalism over centralized planning, the story of this triumph is not without its contentions. The Asian financial crisis in the late 1990s spelt out some of the ravages that financial market liberalization can cause if strong systems of regulation are not put in place to curb the high levels of possible volatilities that are very typical of financial markets. (Stiglitz, 2002)

Liberalized international trade has also come under increased criticism especially from developing countries who claim the current international trade regime is not favorable to them. The mass anti globalization protests and deadlocks during the multilateral trade negotiations at Seattle in 1999 and Cancun in 2003 are a testament to the growing dissatisfaction with the current liberalized international regime. The current multilateral trade negotiations in the Doha Development Round has also been typified by very polarized positions. Developing countries on the one hand are agitating for development issues to made an integral part of the trade negotiations keeping with the objectives of the Agreement Establishing the WTO. Issues like regulation of intellectual property rights under the TRIPS Agreement and its implications for knowledge transfer and development in developing countries is one of the center pieces of agitation. (Van den Bosch 2005) Developed countries on the other hand are agitating for an extension of the mandate of the WTO to cover issues of competition – a form of international competition law under the auspices of the WTO.

Other issues like the unbridled leverage of multinational organizations and the projection of their interests above important developmental and environmental issues in developing countries have also been leveled against free market propositions. Liberalization of markets in countries like China, Bangladesh, India and a lot of developing countries has also witnessed issues like child labor becoming pivotal issues in the international trade system. Consumerism and the tendency to source goods from producers at a very low price has resulted in the lowering of labor and environmental standards. Thus though free market competition is the accepted norm of the present era, the need to stay competitive in the global market has in turn resulted in giant corporations like Wal-Mart in industrialized countries sourcing cheap goods from countries where labor and environmental standards are not respected. (Edmonds and Pavcnik 2005)

In the light of the above, it is evident that though economic liberalism has triumphed, one cannot talk about an absolute triumph. However, the position taken in this paper is in favor of economic liberalism. It is evident that a central planner cannot claim to know the situational circumstances that inform behavior of private actors in the market place and thus cannot meaningfully plan and coordinate such activities towards a specific end. Freedom to act in the market place should be the ethos of the market system and individuals would be motivated to take decisions that will benefit them instead of conforming to decisions already made for them by a central planner. Creativity and productivity would be more assured by the freedom of the individual to participate in the market rather than if his/her participation in the market is planned by government. However, Hayek’s warning against laissez-faire capitalism should be taken more seriously. Disillusionment with capitalism during the early part of the 20th century witnessed a move towards totalitarianism in countries like Russia, Germany and Italy. The lessons of history must be learnt to forestall its repetition in the 21st century. Effective legal regimes must thus be put in place to guard against market failure.

Also, one cannot loose sight of the historical circumstances that inspired the Keynesian model of economic policy. As Demsetz (2002) opined, during periods of emergency (like wars) socialist principles of centralized planning present some notable advantages. Economics is a social science that deals with human behavior which can be very uncertain. The Asian financial crisis is a typical example of how a supposedly good financial market liberalization can seriously go awry. Consequently, no particular economic model can lay claim to providing absolute solutions. Nobel laureate Joseph Stiglitz (2002) thus emphasizes the need to implement market reforms in a sequential order over time instead of revolutionary reforms. China is a shinning example of Stiglitz’s contention. China embarked on gradual market reforms through the 1980s before eventually opening its market to foreign competition when it acceded to the WTO in 2001. By the time of its accession into the WTO China had developed enough local capacity to effectively compete in international trade.  Van den Bossche (2005) has thus posited that they argument in favor of protecting local industries from foreign competition has some appeal, though he admits that protectionism itself does not gaurantee the viability of the protected industries.

In conclusion, given the opportunity to recommend economic policy to the world’s most influential leaders, I would recommend the principles of economic liberalism advocated by Hayek. I would however recommend a total renegotiation of the multilateral trade agreements to ensure market access for all goods and services. Currently, developing countries are marginalized in the international trading system because goods of economic importance to them like agricultural products and textile products face significant trade barriers. High tariffs, quotas and heavy subsidies by developed countries prevent the products of developing countries from competing effectively in the markets of developed countries. Within the WTO at the moment, agricultural subsidies are not regulated under the Agreement on Subsidies and Countervailing Measures. I would advice uniformity in the discipline of subsidies to ensure fair play in the rules of international trade. As Hayek (1944) advocated, a good regulatory framework is needed for competition to work effectively. Where the rules are tilted in favor of some trading blocs, one cannot talk about the triumph of competition. It will be a triumph of the favored.

Stiglitz’s proposition for sequencing market reforms in developing countries should be given more prominence in the trade agenda. Demands of non-discrimination in the international trade regime should be a bit more relaxed for developing countries to enable them build some appreciable level of local capacity to compete at the international level. Charlton and Stiglitz’s argument in this direction (2005) demands attention within the international trade system:

“it is inappropriate for the largest and richest countries to be demanding a quid pro quo from the poorest. (…) Demands for reciprocity ignore the egregious unfairness of the world trade system, which over 50 years has reduced tariffs on goods of export interest to the rich countries and protected goods that should be exported by the poor countries.”  (p.19)

More attention should be paid to development issues in the international trading system as development is one of the foundational objectives in the WTO. The Doha Round should be able to address issues like intellectual property regulation and to incorporate areas where developing countries have a comparative advantage. The piracy of the intellectual property of indigenous societies by so called bio-prospectors from corporations in the developed world is one of the heated issues in the current Doha Round. Evidently, for developing countries to trade effectively in the global market, their comparative advantage in intellectual property products should also be protected.

International rules that protect the comparative advantage of all participants in the international trading system will go a long way to make the triumph of economic liberalism a global triumph and not a selective triumph.

;

;

;

;

;

;

;

;

;

;

;

;

;

;

;

;

;

;

;

;

References and Bibliography

;

“Commanding Heights: The Battle for the World’s Economy”. PBS, 2002

;

Demsetz H., (2002) ‘Toward a Theory of Property Rights II: The Competition Between Private and Collective Ownership’, Journal of Legal Studies, Vol. 31(2), pp. 653-  672

;

Dunoff, J. L, (1999) “The Death of the Trade Regime” European Journal of International          Law, Vol. 10 (4) pp.733-762

;

Edmonds, E. V. ; Pavcnik, N. (2005) ‘Child Labor in the Global Economy’, Journal of            Economic Perspectives, Vol. 19(1), pp. 199–220

;

French, L. J. and Wokutch, R. E. (2005) ‘Child Workers, Globalization, and International          Business Ethics: A Case Study in Brazil’s Export-Oriented Shoe Industry’,             Business Ethics Quarterly, Vol. 15(4) pp. 615-640

 

Johnson, P. M., (n.d.) “A Glossary of Political Economy Terms”.             http://www.auburn.edu/~johnspm/gloss/aggregate_demand (Accessed on            February 10 2008)

 

Stiglitz, J. E. (2002). Globalization and Its Discontents. London: Penguin Books

 

Stiglitz, J. E. and Charlton, A. (2005). ‘The Doha Round is Missing the Point on Helping           Poor Countries’. The Financial Times, December 13, 2005

 

Sutherland, P., Bhagwati, J., Botchwey, K., FitzGerald, N., Hamada, K., Jackson, J. H.,            Lafer, C. and de Montbrial, T. (2004). The Future of the WTO: Addressing         Institutional Challenges in the New Millennium. Geneva: World Trade    Organisation

 

Wolfe, R. and Mendelsohn, M. (2004) ‘Embedded Liberalism in the Global Era: Would            Citizens Support a New Grand Compromise?’. International Journal, Spring, pp.   261-280.

 

Van den Bossche, P. (2005) The Law and Policy of the World Trade Organisation,         Cambridge: Cambridge University Press

 

Von Hayek, F. A. (1944) The Road to Serdom, Abingdon: Routledge

 

Yergin, D. and Stanislaw, J. (1998) The Commanding Heights: The Battle for the World’s          Economy. New York: Touchstone